Can someone bring to light a scenario regarding these two derivative instruments? I really am having trouble distinguishing between the two.
Imagine you are a bank with assorted credit card debt and auto loans on your BS. You could remove them from your BS by securitizing them as 2 distinct ABS issues or you could use a single CDO. A CDS is totally different, its basically an insurance contract on a bond. The seller of a CDS collects a premium and agrees to pay the buyer any losses on the bond resulting from default.
Can you explain CDO’s a bit more in detail?I understand CDS’s but I’m really lost on CDO’s. I understand that CDO’s represent the economic risk of the underlying asset without the legal liability/ownership but not the distinction between both.
manavecplan Wrote: ------------------------------------------------------- > Can you explain CDO’s a bit more in detail?I > understand CDS’s but I’m really lost on CDO’s. > > I understand that CDO’s represent the economic > risk of the underlying asset without the legal > liability/ownership but not the distinction > between both. Actually you’re describing a Synthetic CDO (which uses CDS to create the economic risk without actually holding the assets). A regular CDO starts off with an SPV that takes legal control of the assets to be securitized. I’m not sure how this is presented in the CFAI books but Schweser does a good job of explaining these distinctions.
This is a fairly mundane article, but it could shed some insight. Non-exam related info. though… http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
My overall understanding of the two: -->A CDS is an issurance on a fixed asset/loan, where the buyer of the CDS buys protection on the credit risk. The investors covers the credit risk by buying protection on the underlying subject to credit default. -->A CDO is a pool of cash flow generating assets. Multiple tranches of securities are issued offerring different levels of maturity and credit risks to the investors. The investors are exposed to credit risk by actually holding collateral that is subject to default. --> The only point of similarity is that both are related to credit risk.